'Saintly' Investing Protects for Long Haul

BOSTON (TheStreet) -- Sitting at a poker table with a cigarette and a stiff drink sounds like a good plan if the world is ending. Given the turmoil of 2011, it's no surprise that the Vice Fund (VICEX) has wildly outperformed the market.

On the other hand, investors who stick with a socially responsible (SRI) value approach like the Appleseed Fund ( APPLX - Get Report) have beaten the market by a wider margin over the years.

The Vice Fund, which counts Philip Morris ( PM), Anheuser-Busch InBev ( BUD) and Wynn Macau among its holdings, is up more than 14% this year through June 30, compared to a 6% return on the S&P 500 and the Appleseed Fund during that same time frame.

"The Vice Fund is doing quite well this year," Josh Strauss, portfolio manager of the Appleseed Fund says. "Its performance is very good. Their outperformance is all gambling and tobacco. But it's obviously a different category. Whether the Vice Fund can provide value in a portfolio, it certainly would have low correlation to the SRI fund, that's for sure."

The Vice Fund has an average annualized return of 3.9% over the past three years, greater than a 3.3% increase on the S&P 500 but well below the 14.7% return of the Appleseed Fund. That strong performance earned Appleseed the Morningstar accolade of top-performing mutual fund across every asset class during the 2008 and 2009 span.

The Appleseed Fund has the socially responsible mandate to exclude the so-called sin stocks -- alcohol, tobacco, gambling and porn. Strauss also excludes "too big to fail" banks, due to the view that the banks "have been managed in an irresponsible way with huge leverage," Strauss says.

This socially responsible mandate helps the fund limit business risk. For example, stocks excluded from SRI funds, like Philip Morris, face massive litigation risks and even increased taxes by the government.

With all of the uncertainty in the market because of the downgrade of U.S. debt by Standard & Poor's, weak economic data and continued debt woes in Europe, this defensive approach has held up thanks a portfolio filled with companies in health care and consumer staples.

However, Strauss doesn't want to be pigeon-holed by the SRI mandate and instead wants the Appleseed Fund to be known as a go-anywhere fund that invests up and down market capitalizations and asset classes in order to generate value for investors and protect capital in rough economic times.

"We look for businesses with quality balance sheets so we can protect our capital on the downside," Strauss says. "We want companies with robust cash flows and competitive moats, like pricing power. We're worried about inflation impacting our portfolios. Companies with pricing power have the ability to maintain margins even in inflationary environments."

In order to hedge against inflation, the Appleseed Fund has been invested in gold since 2006, when the precious metal traded for only $700 an ounce, considerably less than its price of nearly $1,700 an ounce now. Years ago, the investment was a bet that housing prices were unsustainable, but gold prices continue to increase as the dollar has plunged.

"The investment case for gold remains strong," Strauss says. "The Bank of Korea just started buying gold again. What happens when China begins to make that move? You have to look at it as a portfolio hedge."

Strauss prefers to discuss his equity picks, as "we're stock pickers at the end of the day," he says. One place that his fund has found value has been Japan. The Appleseed Fund began investing in a handful of Japanese companies shortly after the earthquake and subsequent tsunami that ravaged the country earlier this year. The bets turned out to be extremely well timed.

To show how the fund can go anywhere, Strauss highlights Appleseed's investment in Mabuchi Motor, a maker of small DC motors used in everything from digital cameras to toothbrush to car components. Strauss notes that while the company is based in Japan, almost 90% of its sales come from outside the company.

"The stock trades at a discount to book value," Strauss says. "There is a significant amount of cash on the balance sheet. And you get a 2.6% dividend yield. It is a free-cash-flow generating business that no one cares about. No one wants to own it. There's very low downside. In this kind of market, I'll take it."

Closer to home, the Appleseed Fund is a holder of insurance broker Willis Group ( WSH). One of the reasons Strauss continues to like the stock is that the company has no underwriting risk but still stands to benefit from pricing changes in the insurance industry.

"The stock got hit because they did an ill-timed acquisition in 2008, but since then they've been moving up because of the improvement in pricing," Strauss says. "We got in around $27 and we think the stock still has a ways to run. You had the Japanese earthquake and you've had terrible weather all over the place, all of which are positive for Willis. If you get a bad hurricane season, this stock could really move."

Strauss says that Willis Group, which is essentially a bet on asset inflation, offers a 2.7% dividend yield and trades at 12 times earnings, a discount to historical levels.

Sealed Air ( SEE - Get Report), which makes protective packaging like the Bubble Wrap brand, is another favorite of Strauss. The stock has been hammered by more than 30% since its acquisition of commercial cleaning solutions maker Diversey, and Strauss sees plenty of value.

"They chose to do an acquisition where the price wasn't that great, and the stock has been just terrible," Strauss says. "On a pro-forma basis, the stock is trading at eight times earnings with an 11% free cash flow yield. The dividend yield is about 2.5%. This is a business that is not particularly cyclical. It's dirt-cheap. I think I have a double on my hand within the next couple of years."